KPMG Hit With Billion-Dollar U.S. Lawsuit Over Audits of Subprime Lender

Accounting giant KPMG was hit with a billion-dollar lawsuit Wednesday over claims its “grossly negligent audits” helped trigger the collapse of a top subprime mortgage lender at the start of the U.S. housing crisis.

New Century Financial Corp, the largest independent provider of home loans to people with poor credit, filed for bankruptcy two years ago amid mounting customer defaults.

Its failure rippled across the U.S. mortgage lending industry, sparking a string of other bankruptcies that roiled financial markets as banks booked losses on billions of dollars in mortgage-linked securities at the heart of the current global financial crisis.

The lawsuit, on behalf of a liquidating trust formed by New Century debtors, was filed against both KPMG International and its U.S. arm, KPMG LLP.

It accuses KPMG of helping cover up “catastrophic” problems at New Century — including accounting and financial errors — that led to its collapse.

“As New Century’s auditor, KPMG failed its public watchdog duty,” the suit says.

KPMG spokesman Dan Ginsburg said he had not seen the suit but issued a statement saying the company had acted “in accordance with professional standards” in its dealings with New Century.

“We will vigorously defend our audit work. Any implication that the collapse of New Century was related to accounting issues ignores the reality of the global credit crisis. This was a business failure, not an accounting issue,” the statement said.

‘DOING THE UNTHINKABLE’

The suit demands at least $1 billion in damages.

At one point, KPMG “did the unthinkable for a public auditor,” the lawsuit alleges. It claims that KPMG issued an audit report on New Century’s 2005 financial results before its audit was complete, “falsely enabling” New Century to file its annual report with the U.S. Securities and Exchange Commission.

“This is inaccurate,” Ginsburg said.

Many of the problems at New Century stemmed from aggressive business practices that saw the company grow from originating $357 million in mortgage loans in its first year of operation in 1996 to about $60 billion in 2006.

Despite a denial of wrongdoing, a report by a court-appointed bankruptcy examiner found last year that KPMG contributed to New Century’s questionable financial reporting practices through “troubling and puzzling conduct” including its alleged negligence.

“Despite KPMGI’s promise that it would ensure that KPMG LLP audit services would comply with professional standards and regulatory requirements, KPMG LLP conducted grossly negligent audits and reviews of New Century that violated both professional standards and regulatory requirements,” the complaint says.

The suit was filed by Venice, California law firm Thomas Alexander & Forrester LLP. Different, but overlapping versions of the complaint, targeting the Netherlands-based parent company and U.S. arm of KPMG separately, were filed in federal courts in New York and Los Angeles.

The New York suit could mark the first time a Big Four auditing firm is held legally liable for the actions of its U.S. subsidiary, said Steven Thomas, the lead attorney for the plaintiff.

“This wasn’t an audit failure that affected a small company, it wasn’t an audit failure that just affected their creditors, or even just affected the U.S. financial system. This had a worldwide impact,” Thomas told Reuters.